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Snap's first-ever decline in users could be a sign of trouble

If Snap’s (SNAP) second-quarter earnings are any indication, Snapchat’s user growth may have flatlined — the parent of the ephemeral messaging app beat expectations on revenue but fell far short of expectations on user growth.

The company’s stock rallied in after-hours trading on Tuesday but was down more than 4% around 1:45 p.m. EDT on Wednesday.

On Tuesday’s earnings call, Snap CEO Evan Spiegel chalked up Snapchat’s first-ever dip in daily active users (DAUs) — from 191 million DAUs in the first quarter to 188 million DAUs in the second quarter — to a controversial redesign rolled out last November. Snap also declined to give DAU guidance for the third quarter, cautioning that third-quarter DAU growth rates have historically trended down following the second quarter.

“The redesign clearly had an impact, so I’ll go with the explanation — however, the caution about seasonality for Q3 came off a bit odd and suggests that they expect another decline [next quarter],” says Wedbush Securities analyst Michael Pachter. “Keep in mind that they grew in Q3 every year since they showed numbers, from 57 – 62 million from June – September 2014, 86 – 94 million in 2015, 143 – 153 million in 2016, and 173 – 178 million in 2017. They didn’t grow in every region, but were no worse than flat sequentially. Therefore, calling out seasonality as a reason to be cautious is concerning.”

Co-Founder and CEO of Snap Inc. Evan Spiegel.

If anything, Snap’s first-ever drop in DAUs suggests the competition, namely Facebook (FB), is also hitting Snap where it hurts: its user base. In August 2016, Instagram introduced Instagram Stories — a blatant copy of Snapchat Stories — to great success. Already, the popular Instagram feature has 400 million DAUs, which is more than twice of Snapchat’s total DAUs.

“Keep in mind that Instagram is over 1 billion users, and Instagram Stories is keeping those users from switching to Snap,” Pachter adds. “That suggests that market share gains from the Instagram base are going to be difficult to capture.”

‘Some types of changes are happening with users’

Gartner analyst Brian Blau echoes Pachter’s sentiments.

“Given that Snap hasn’t shown consistent growth even before the app redesign, it’s likely some type of changes are happening with their users,” Blau says. “Competition, especially from large consumer ecosystem players, means they have to advance in many areas as well as continue to be a leading app destination if they expect to grow and monetize users more effectively.”

Snap hasn’t had an easy path since Snapchat launched in 2011. Although the ephemeral messaging app quickly gained popularity in earlier years among teens and millennials seeking a more private, hipper alternative to Facebook, the company has had trouble consistently delivering significant user and revenues growth to investors since it debuted as a publicly-traded company.

The company has also faced something of an identity shift. In September 2016, Snap revealed its first-ever hardware product: Spectacles, a pair of camera-enabled sunglasses. When it filed for its IPO the following year, the social-media startup made the surprising assertion, “Snap Inc. is a camera company.”

But most people still associate Snap with Snapchat. And each quarter that passes without some consistent and significant growth in the user base means the struggle to attract new users and ultimately advertisers will become even harder.

JP Mangalindan is the Chief Tech Correspondent for Yahoo Finance covering the intersection of tech and business. Email story tips and musings to jpm@oath.com. Follow him on Twitter or Facebook.